Background
There is little doubt that we are witnessing an increased focus on climate change management, sustainability and good corporate governance over the last few years. Interest in this topic from investors, stakeholders and regulators continues to pique globally, due in large part to the United Nations Climate Change Conferences — or COP — held each year. The latest of these conferences — COP29 — will be held in Azerbaijan from 11 to 22 November 2024. The trend towards green initiatives is likely to continue as these challenges become more prevalent in society. This in turn has led to an increased emphasis on Environmental, Social and Governance (ESG) reporting for companies. Indeed, one of the many topics up for discussion at COP29 is the increasing onus on corporations to support socially-responsible investing as part of a wider ESG plan.
About the Guide
This guide takes you through the fundamentals of ESG reporting. In particular, we focus on the why and how, and what companies need to be aware of in order to prepare for mandatory climate-related reporting requirements which will be phased in, in January 2025.
With this significant development, we are excited to present the following two new chapters in 2024:
- Chapter 5 – Mandatory climate-related financial reporting — Takes you through the important changes which will commence (in a phased approach) on 1 January 2025, to ensure corporations are prepared.
- Chapter 7 – ESG and director duties — Outlines the important role which company directors play in managing ESG risks and opportunities and fostering a corporate culture which is supportive of ESG.
We are also excited to introduce a new ESG chapter to our commentary available in our Company Law practice area in 2024. Refer also to our Case Table: Corporate Greenwashing Examples for important information on how the corporate regulator is tackling this practice.
Table of Contents
- Chapter 1 — Introduction — What is ESG reporting?
- Chapter 2 — Environmental reporting
- Chapter 3 — Social reporting
- Chapter 4 — Governance reporting
- Chapter 5 — Mandatory climate-related financial reporting (New in 2024!)
- Chapter 6 — Why is ESG reporting so important?
- Chapter 7 — ESG and director duties (New in 2024!)
- Chapter 8 — What next?
- Chapter 9 — Conclusion and key takeaways
Chapter 1 — Introduction — What is ESG reporting?
ESG reporting is the disclosure of a company’s performance in relation to ESG risks and opportunities, both qualitatively and quantitatively. The purpose of ESG reporting is to explain how the material topics — of environmental impact, social setting and corporate governance — inform and impact on a company’s strategy and overall performance. Essentially, any listed entity should disclose whether it has any material exposure to economic, environmental or social sustainability risks and, if so, how it mitigates or manages those risks. This can be important for investors in understanding a company’s risk profile and future growth prospects. Indeed, the Australian Securities and Investments Commission (ASIC), is a supporter of what has become known as smart ESG investing.
Whilst there can be a variety of ESG factors at play for a company at any given time, it is unquestionable that many of these factors can impact on the ability of companies, and their investors to achieve sustainable financial growth and prosperity. Investors need accurate, timely and comparable information in order to identify and manage any exposure to ESG investment risks. In turn, companies need consistency in the information provided to institutional investors, whilst balancing ESG reporting obligations to ensure that they do not impose undue costs, competitive disadvantages or other commercial burdens on the business.
Getting started
To get started with ESG reporting, companies should first clearly identify their business activities and supply-chain information. This, in turn, will define their reporting boundaries, in relation to included and excluded business entities, such as subsidiaries, affiliates and joint ventures. Companies should also identify their key target audience for ESG reporting, such as investors, clients, financiers, shareholders, government and the community. Companies need to ensure that their ESG reporting addresses the needs of this target audience accordingly.
Understanding material ESG risks
ESG risks are considered material risks, where a reasonable person would consider the information to have an impact on a company’s valuation or the sustainability of its operations. The materiality of ESG risks will vary greatly between companies, depending on their size and the nature and complexity of their operations. Companies should consider the future business environment or impact of megatrends on their operations. Megatrends are major global societal and transformative forces which present short-term or longer-term risks and/or opportunities to companies and their shareholders. Megatrends may include:
- Environmental trends — Including climate change, sustainability, ecosystem decline, greenhouse emissions targets and carbon credits.
- Social trends — Including human resources, occupational health and safety (OH&S), ethically-sourced materials, diversity, gender equality, discrimination, ageing demographics, population growth, urbanisation, wealth distribution, material resource scarcity and food security.
- Governance trends — Including good corporate citizenship, risk mitigation, change management, digitisation, artificial intelligence and cybersecurity.
ESG reporting is not about companies disclosing a forecast concerning their future value to investors or shareholders; rather it is a measured and considered disclosure based on agreed reporting standards, key performance indicators (KPIs) and currently available information, as it relates to scenario planning for the future.
With regards to quantitative reporting, companies should report against current ESG targets, as well as reporting the company’s historical performance against legacy targets.
Chapter 2 — Environmental reporting
A company’s operational activities — which may stem from its supply chain — may impact on the environment and hence can have significant implications on shareholder value. This is because an environmental incident may result in:
- production disruptions as the incident is investigated and new safeguards are put in place,
- capital costs associated with remediation of the incident,
- legal costs, compensation or damages to affected clients, business partners or communities, and
- impact to the company’s reputation, which may result in product boycotts, or the need for new policies, procedures and/or regulations.
Investors are becoming increasingly aware of the negative impacts of a company’s operations on the environment. Such operations may include the depletion of resources, renewables and the disposal of waste, including hazardous and/or toxic waste. A company with a significant environmental impact and a lack of commitment to the management of environmental considerations will present a higher risk for investors.
Environmental reporting should always be tailored to each business. For example, an environmental issue such as pollution, will be more relevant to a certain industry sector or business, such as mining. On the other hand, investors may be less concerned with companies with a smaller environmental footprint, such as a retail store.
Climate change
With so many countries committing to global targets to reduce carbon emissions in order to address climate change, the risk of climate change regulation impacting on companies is only likely to grow. Whilst the regulatory mechanisms to achieve emissions reductions — such as carbon price, emission abatement grants and pollution controls — may change over time, the long-term trend is clear.
Climate impact risks are clearly more relevant for certain sectors, industries or companies. For example, those companies more heavily invested in fossil fuels, mining or forestry. However, over time other risks may impact a broader range of companies. For example, a company’s consumption patterns may change in favour of low-carbon goods and services, leading to significant changes in industry structure. The physical effects of climate change, such as floods, fires or hurricanes, may also put business assets at risk.
A company which fails to understand its climate impact could risk:
- Higher costs in order to comply with increased carbon regulation,
- Loss of market share and/or business reputation, as clients move to low-emissions suppliers, and
- Damage to business assets as the physical impacts of climate change increase.
Greenwashing litigation
Greenwashing is the practice of conveying a false impression, or providing misleading information, concerning a company’s products, approach and performance, ie alleging that a company is more environmentally or socially sound or sustainable than they actually are. Such false claims can have serious consequences, including penalties, reprimands, damage to brand and reputation, litigation and prosecution.
ASIC has listed greenwashing as one of its enforcement priorities for 2025 and beyond.
Refer also to our Case Table: Corporate Greenwashing Examples available to paid subscribers of CCH iKnowConnect for an explanation of greenwashing, practical advice on avoiding greenwashing and examples of where the corporate regulator has taken enforcement action.
The fact that ASIC has been successful in every greenwashing action to date, serves as a sobering reminder to corporations to do the right thing when it comes to making environmental or sustainability claims.
Company directors are becoming increasingly aware of this increase in greenwashing litigation. It is essential that directors clearly understand the company’s ESG reporting policy, in order to ensure compliance with a company’s environmental commitment, or KPI targets, for net zero emissions.
Indeed, where reliance is placed on supply chain greenhouse gas emission reduction strategies, then verification of those strategies is essential in order to minimise the risk of greenwashing liability.
Chapter 3 — Social reporting
Companies are increasingly subject to a “social licence to operate”. This means that businesses can no longer be accountable to just their shareholders. A company’s social licence is inextricably linked to the quality of its products/services as well as its brand and reputation in the marketplace. A company’s obligations also extend to its clients, suppliers and employees. This move towards social reporting is no doubt fuelled by the increased use of social media which can both promote or demote a business. It is also linked to a corporations’ commitment to the community in terms of “giving back” via charitable endeavours for staff, fundraising events and donation drives.
Good social reporting includes good people management. There is evidence to suggest that strong HR management will contribute to employee productivity, loyalty and engagement, which in turn can save investor costs in staff turnover and volatility. In addition, companies which are engaged in high-risk work, such as construction, will have a higher cost base in workers compensation premiums, safety equipment and safety procedures. Such companies can often face severe operational and reputational damage for any OH&S incidents, particularly worker fatalities.
Investors will also wish to be informed of a company’s commitment to ethically sourced products in their supply chain, or the fair treatment of lower-paid workers, which often comes down to basic human rights.
Social reporting should also cover any ethical issues such as the risks of:
- bribery and corruption,
- fraudulent conduct or tax evasion,
- money laundering or the embezzlement of funds,
- market manipulation or the inflation of project costs,
- lack of protection for corporate whistleblowers, and
- poor corporate culture.
Chapter 4 — Governance reporting
Good corporate governance is focused on the quality of management within an organisation and the quality of risk oversight by the board. Investors expect good corporate governance reporting in order to better understand the framework, policies and incentives in place to ensure best performance by the company.
Sound corporate governance implies that companies are seen to be good “corporate citizens”. It requires robust audit and oversight policies by independent, impartial auditors, to ensure that a company is meeting all its legislative, regulatory and reporting requirements.
It is essential that companies are following best practice guidelines and standards when it comes to corporate governance. Otherwise, investors, and other stakeholders, are likely to lose confidence in a company’s robustness and longer-term sustainability.
Chapter 5 — Mandatory climate-related financial reporting
In a major development in 2024, the Treasury Laws Amendment (Financial Market Infrastructure and Other Measures) Act 2024 (Cth) (Act) commenced on 18 September 2024. The passage of this Act means that, from 1 January 2025, many large Australian corporations and financial institutions will be obliged to prepare annual sustainability reports containing mandatory climate-related financial reporting. This pivotal legislation marks a significant shift in the way in which businesses prepare their annual reporting suite, and establishes Australia as a global leader in mandatory climate reporting against standards which are aligned with the International Sustainability Standards Board (ISSB).
Australia has adopted a phased approach, as follows, in defining the entities subject to the new regime:
